In the global market of rough and polished diamonds Russia is formally represented in all parts of the diamond pipeline. However, though Russia is one of the world’s pace makers in diamond mining and rough sales, its share in global diamond cutting and polishing is about four percent, while in jewelry making and retail it is less than one percent. And this kind of structure of the Russian rough and polished diamond industry conceals a considerable potential for its development.
Currently, the diamond industry, as well as other sectors of the Russian economy, found themselves in an altogether new business environment due to large-scale shifts in the macroeconomic situation. There has been a sharp drop in the Russian ruble exchange rate towards the U.S. dollar accompanied by a high rise in lending rates. Inflation went up to double-digit values and will continue to remain high for a long time. Consumer demand for all kinds of goods and services is falling, which is especially true for diamond jewelry, and this fall will only deepen in the mid-term.
On the backdrop of relatively stable world prices for rough diamonds (in contrast to oil prices), the diamond mining sector was not only affected, but even received additional benefits and a good push for development, as it is evidenced by performance reports posted by ALROSA. Meanwhile, other segments of the domestic diamond industry, on the contrary, came under severe pressure.
Faced with decreasing demand, jewelers and retailers are able to change their product range to at least minimize losses. Diamond manufacturers happened to be caught between a rock and a hard place. On the one hand, rough turned very expensive, while on the other hand domestic demand for polished diamonds from jewelers came to naught.
The sector of diamond cutting and polishing within Russia’s diamond industry is not homogeneous. Diamond manufacturing is represented by three industrial clusters located in Moscow, Smolensk and Yakutia. In terms of production, they are comparable, but they differ very significantly in their positioning on the market. Brillianty ALROSA, which is a net exporter, will probably even have a higher profit margin, being supported by its parent company. Kristall, which is a state-owned manufacturer based in Smolensk, has also a very high proportion of export sales and may rely on financial support from the federal government. Diamond manufacturing factories located in Yakutia are private. Their share of average export revenues across the diamond cluster is significantly lower compared with others.
Last year, profits were made only by those diamond manufacturers in Yakutia which, in addition to diamond cutting, were pro-active in developing their own jewelry production, as well as retail networks. Right now, it is not anymore an advantage, because they cannot go into other segments of the jewelry market. Starting from September and October last year, Yakutia’s diamond manufacturers sharply reduced purchases of rough from Yakutsk Diamond Trading Enterprise (YaPTA), and one of the recent industry leaders, Yakut Diamond Company, lost its membership in the ALROSA Alliance due to financial difficulties. And it seems this is not the last sacrifice.
It appears that market players will feel the full impact of the new macroeconomic situation by mid-year. However, it is already clear that without adequate support the industry, at least in Yakutia, may at best face a threat of stagnating and at worst – a threat of dying.
For the majority of diamond manufacturers there is only one possibility if not to develop their business, but at least to save it, and this is to boost their export of goods and services to its maximum, aggressively tapping into new markets.
A weaker ruble creates a good background for this movement. Russian diamond cutters are traditionally, due to relatively high productions costs, specialized in processing high-priced rough - large and high-quality diamonds. Their main competitors are manufacturers of polished diamonds from Belgium, Israel, the United Arab Emirates and to a certain extent from China. These are the countries to contest for a share of the global market. In the past year, the US dollar was growing towards almost all world currencies. But the Russian ruble showed the strongest decline (about 55%). Euros and Israeli shekels fell by about 17-18%, while the national currencies of the United Arab Emirates, India and China almost retained their positions. It is obvious that Russian companies received the greatest benefit from the devaluation of their national currency.
Russia is the only country on this list, which is producing rough diamonds. This gives an additional advantage to Russian diamond cutters due to the possibility to purchase rough at domestic prices, without paying the export duty of 6.5%.
These two aspects give the Russian diamond manufacturing strong trump cards to compete in the the world market, but unfortunately, they are not enough.
The current Russian regulations governing the turnover of precious metals and stones, as well as finished goods, the country’s tax and customs proceedings, the hampered access to financing for market players, the structure of the diamond industry inadequate to market conditions, where there is virtually no infrastructure for secondary circulation of raw materials and finished products are critically reducing the competitiveness of Russian companies on the world market. This is especially evident against the background of a wide range of tax and customs preferences, simplified and speedy administrative procedures, and liberalized regulations on precious metals and stones, which are increasingly used by the states taking part in the global diamond industry to support the competitiveness of their national companies.
It is suffice to mention the policy pursued by the Indian government, which successfully renders financial support to market players through state banks offering quite easily available resources for importing rough and exporting finished goods through such entities as ММТС (a state-owned import-export company trading in minerals) and HDCPL, which is a joint venture between De Beers and the Indian Ministry of Commerce and Industry. The Indian government interacts with market participants through the national Gem & Jewellery Export Promotion Council. India creates special economic zones with preferential tax treatment and simplified customs procedures. Israel has also created favorable conditions for the development of the diamond industry, including ready available financing, well-developed market infrastructure and export support at the state level. Thanks to these policies these countries are rapidly developing innovative technologies. It is no coincidence that India and Israel have made the greatest progress in recent decades.
Without similar measures of state support Russian diamond manufacturers and jewelers will be in a worse situation compared with their competitors, and are unlikely to achieve success on the world stage.
Recently, Russia adopted the law on territories of priority social and economic development, which would seem to remove most of the problems and provide excellent opportunities for business. However, the initiative to establish a territory of priority development (TPD) specialized in manufacturing polished diamonds and jewelry under the name of Diamond Valley will most likely not be realized.
This may have behind a set of objective and subjective reasons. But it must be admitted that the production of diamonds and jewelry in terms of the ideology upheld by the adopted law is an insufficiently ambitious project to become the core of a TPD. It would look more organic to establish such a production cluster as part of a larger area, such as a TPD on Russki Island in Vladivostok, if, of course, it will come to existence.
Another solution would be to create separate production sites in Moscow, Smolensk and Yakutia making them "free customs areas." This kind of operation mode is already practiced by the automotive industry, where everything is fine-tuned to the smallest detail. The free customs area regime provides almost all the possibilities needed for production, export and import operations, saving time and efforts and solving the problem of VAT in terms of exports.
Such an area already exists in Moscow on the premises of Diamond World, OAO with a full set of necessary infrastructure. Currently, its operational load is incomplete. However, if it will be given the status of a free customs area it may attract a sufficient number of people willing to move their diamond and jewelry manufacturing facilities to this area. Similar sites could be established in Yakutia and Smolensk. The free customs area regime is introduced by decrees of the Russian Federation government. Therefore, such areas may be established very quickly if the government is sufficiently interested. It is important for the industry to have goods move freely from one area to another, as if being outside the customs territory. This provides flexibility in their circulation even to a greater extent than in a TPD.
In April, Israel opened a new diamond-cutting center established to revive the country's diamond manufacturing industry. Small-scale diamond companies, as well as young firms are given there, on a contest basis, the possibility to take on lease technological equipment and have shared access to expensive high-tech equipment, which many companies are not able to buy. The main condition for this kind of support is to produce polished diamonds, rather reselling rough. This extremely interesting initiative could be successfully replicated in Russia.
Our competitors are constantly working to improve their technology, create proper environment for business and introduce innovative solutions in its organization, and we need to make up for leeway.
For both objective and subjective reasons, there are no framework and mechanisms in Russia to ensure an effective commercial circulation of raw materials and finished products on the secondary market, the organization of which is so attentively attended everywhere in the world. More than 1,500 companies are involved in the secondary turnover of raw materials and finished products in the world diamond market. They redistribute rough providing it, among other things, to medium and small companies and shape the flow of finished goods in domestic and foreign markets. The absence of such a basic market system is the most important structural shortcoming of the diamond industry in Russia, which creates very big problems.
Its creation could begin by establishing a large public or public-and-private company on the model of MMTS and HDCPL in India. Its functions would include, among other things, the provision of rough to medium and small diamond and jewelry manufacturers, support for their export and import operations and projects, as well as assistance in tapping into new international markets. The company could also become the largest domestic partner of ALROSA purchasing its rough on a common basis, re-sorting it to offer an optimal product mix to domestic factories, redirecting unclaimed rough to foreign markets and supplying it to factories on tolling or credit terms.
This company would have a much easier access to government guarantees and loans, including from foreign banks; it could attract foreign strategic investors to the industry and take part in projects at an intergovernmental level. As an example, there may be mentioned the initiative of the Indian side to adopt intergovernmental agreements, including in the field of customs, aimed at increasing mutual turnover of rough and finished goods in the diamond industry, which was launched at the World Diamond Conference, recently held in New Delhi. It is also important that this company could provide a good start for new business projects and contribute to investment attractiveness and further development of the industry on a broad scale.
From a practical point of view, the company could be created in the form of a public entity, for example, on the basis of the Almazyuvelirexport Foreign Trade Association, and to be located and operate in the free customs areas mentioned above. It could be headquartered in Moscow and have its branches in Yakutia and Smolensk. The territory of Diamond World, OAO in this case could be the nucleus of the future diamond center, such as, for example, the one in Israel’s Ramat Gan, which, incidentally, has been built in the physical and institutional sense for several decades. The already existing infrastructure makes it possible to accomplish this task much faster.
It is expected that a federal law on export promotion will be adopted in the nearest future and meanwhile it was decided to authorize Vnesheconombank (VEB) to create a new federal institution to conduce development - the Russian Export Center, which is to to provide financial and non-financial support to Russian companies involved in export operations. The company to be established could be an efficient industry partner for this center.
It seems that such an approach to re-engineering the structure of the Russian diamond industry could give a powerful impetus to its development. It corresponds to the interests of both the state by providing market transparency and to the interests of Russian diamond and jewelry manufacturers.
In my opinion, to solve the problems of funding the diamond cutting industry in Russia it is necessary to take advantage of the state program of lending to small and medium-sized businesses, which is implemented through MSP Bank (VEB’s subsidiary) and the Credit Guarantee Agency. Most private diamond manufacturers fit well into the requirements to take part in the program being medium-sized businesses with an annual turnover of up to 1 billion rubles. Incidentally, this threshold is supposed to be raised up to 2 billion rubles. The program opens a possibility to use a wide variety of instruments, such as short-term and long enough loans, including development loans, financial leasing and factoring, thereby covering a very wide range of needs experienced by companies.
Diamond market players and bankers should also joint their efforts and take into account the available international experience to develop a national system of criteria and mechanisms that would make it possible to minimize the risks of Russian banks in extending credits to the diamond industry. It appears that these risks are mainly associated with the mechanism and criteria of fair valuation of rough diamonds and polished diamonds as collaterals. The experience of India, Israel and quite recently that of the United Arab Emirates, where banks are lately being more and more involved in operations on the diamond market, permits to count on a successful outcome of such an initiative. Of course, in the first stage it would be good to attract large government-owned banks to these operation, such as Sberbank, VTB, or, for example, Eximbank of Russia.
Russian retailers may play a very important role in increasing investments in the domestic diamond industry. One of the modern trends in the development of the diamond industry is the increasing penetration of major retailers into jewelry and diamond manufacturing and even into diamond mining projects. It seems that the Russian retail sector has much greater financial resources than diamond cutters and jewelers, and perhaps it is interested in tapping into foreign markets in much the same way as they are. Not so long ago, Almaz-Holding announced its intention to enter the Chinese market investing up to $ 10 million into new business in the first stage. Efforts to gain a foothold in foreign markets in the retail segment are also made by some Yakut companies developing diamond and jewelry manufacturing and retail trade in Russia. The Russian diamond industry needs to consolidate its market players, so that this can pay back on a very large scale.
This will not at all cancel the task of finding and attracting strategic foreign partners present above all in the most promising regional markets.
Western Europe, Israel, the UAE, Japan and partly the United States remain to be the main destinations of Russian diamond export. Meanwhile, the world market of final goods - diamond jewelry – is facing big changes. Diamond sales are growing in India and China. The latter is already the second largest player after the United States in the global market and appears to be the most significant driver for the development of the global diamond industry. In the future, the center of gravity in global diamond jewelry sales will be more and more shifting to Asia and other emerging markets. According to McKinsey Global Institute, 600 major urban centers only are currently producing 60% of the world’s gross domestic product. This is where major demand for luxury goods is concentrated. By 2025, the overall picture will not change. However, about a quarter of these 600 cities comprising megapolises of the most developed countries, especially in Europe and the United States, will be replaced by 93 cities from developing countries.
It can be expected that besides the BRICS nations demand for diamond jewelry will also grow in the South American countries - Argentina, Chile, Uruguay, Colombia and Ecuador, - which are now close to Russia by per capita purchasing power parity in terms of GDP (being ahead or behind it), while the share of the middle class there is high and growing rapidly, also due to the peculiarities in the pattern of their immigration flows. No wonder, the new center of diamond trade, which in future is set to be a pacemaker in the market, is being created in Panama. Russia has close political and economic ties with all the above countries, which have recently been extensively expanded and strengthened.
This opens up very good opportunities for Russian diamond manufacturers, jewelers and retailers to enter these promising markets.
So then, the preconditions for a powerful development of the Russian diamond and jewelry manufacturing sector are there. These include the weak ruble, the possibility to use the existing institutional capacities, such as free customs areas on the premises of separate specialized sites, the state program of lending to small and medium businesses and the export supporting system currently being developed. The direction of development is obvious – it is export focused on new and promising markets. It remains to complete the diamond industry framework furnishing it with a system of secondary circulation of precious metals, stones and finished goods, develop interaction between the industry and banks, create production and trade clusters, ensuring equal access for all market players, entrants among them, to new technologies and essential services, including support in foreign markets.
The breakthrough is possible, but on one condition and it is the consolidation of efforts on the part of business and government. It is hoped that the state will support this approach, while business will think about new models of development.
Nyurgun Timofeev, Chairman of the Diamond Council under the President of the Republic of Sakha (Yakutia)
